Merchandise inventory is one of the types of inventory that directly and substantially impacts a companyâs financial health.
Ignore merchandise inventory and you immediately squander an opportunity to enhance the health of your business. Embrace itâlearn everything you can about itâand youâll have taken one of the biggest steps toward profitability a company can take.
Introduction to Merchandise Inventory (Financial Accounting Tutorial #28)
Why is it important to understand merchandising inventory?
Accountants and financial professionals need to understand the process of merchandising inventory because its crucial for accurately calculating expenses, assets and overall profitability. Additionally, accurately calculating merchandise inventory requires knowledge of several important financial terms related to this process:
What is merchandising inventory?
Merchandising inventory is the process retailers use to track the products they sell for profit along with the related account on a balance sheet. The merchandise inventory may account for many businesses largest assets, and when retailers sell merchandise inventory during an accounting period, they calculate these costs under the costs of goods sold. If the merchandise inventory is left over after the accounting period ends, then retailers include the merchandise inventory as current assets.
What type of account is merchandise inventory?
Merchandise inventory accounts for all of a retailers acquired products that they intend to resell. These goods are typically in transit from merchandise suppliers, in storage facilities, on display in stores and can even be on consignment in other locations. Because merchandise inventory includes physical goods, a retailer includes this as a current asset.
When a business accountant organizes the balance sheet for the accounting period, they record any inventory left over as merchandise on hand, listing it as an asset and recording it as a debit to accounts payable. If the retailer makes a purchase for merchandising inventory, they record this as a debit to the inventory account and a credit to accounts payable.
Perpetual versus periodic inventory procedures
When retailers merchandise inventory, they typically follow one of two inventory procedures—either a perpetual or a periodic inventory procedure. The end result is the same between these two methods, where accountants ultimately calculate the costs of goods sold and current assets to report these accounts on the balance sheet. However, these two methods have different processes when it comes to accounting.
Perpetual inventory procedure
In perpetual inventory merchandising, retailers are continuously updating information regarding the inventory they sell. The updates retailers make to the financial records typically include additions to the inventory, subtractions from the inventory, transactions made during the accounting period, records for returned goods and recent sales and purchases. The perpetual inventory procedure is the most common system for tracking inventory because it monitors all aspects of merchandising inventory in real-time.
Transactions that a retailer makes during an accounting period with respect to updating inventory information generally include:
Periodic inventory procedure
With the periodic inventory method, retailers only update the ending inventory balance when they perform a physical inventory count. Companies that use the periodic method of tracking inventory typically perform physical inventory counts once every quarter. Periodic inventory tracking also requires retailers to list inventory purchases between inventory counts in a different account than perpetual tracking.
When purchases are made between a retailers physical inventory count, the retailer includes these transactions in the purchases account. Once they perform the next physical inventory count, the balance in the purchases account moves to the inventory account. The retailer then adjusts this value to match the costs of their ending inventory.
Example of calculating merchandise inventory
To understand merchandising more clearly, the following examples illustrate how a retailer calculates and records merchandise inventory:
Assume a company that sells bulk cleaning products is calculating its merchandise inventory. The company accountant uses multiple elements from the companys balance sheet to find out the current value of the companys merchandise on hand. The accountant uses the following financial information:
The accountant starts by calculating the beginning merchandise inventory using the formula:
Beginning inventory = (Ending inventory + COGS) – purchased inventory
Assuming each cleaning product costs $20 each, the company sells 14,000 cleaning products, purchases 650 and is left with 500 products in stock. Using the formula, the accountant calculates the beginning inventory as:
($10,000 + $280,000) – $13,000 = $277,000
The accountant now has the beginning inventory value to use for calculating merchandise inventory using the formula:
Merchandise inventory = (cost of goods available for sale or beginning inventory) – COGS
Plugging the values into this formula, the accountant gets:
Merchandise inventory = ($277,000) – $13,000 = $264,000
The total merchandise inventory for the accounting period is $264,000. The accountant can use this information to determine how best to allocate extra assets, how to spend funds for necessary supplies and additional applications for the companys revenue. Understanding merchandise inventory is a critical aspect of accurately determining the companys profitability and financial health.
Furthermore, accountants typically consider merchandise inventory as the ending inventory balance because that is the figure that companies report on the balance sheet. This value tells companies how much they have in inventory thats ready to be sold so they can better set revenue goals and inventory key performance indicators.
What are the two types of merchandise inventory?
- Beginning inventory = (Ending inventory + COGS) – purchased inventory.
- ($10,000 + $280,000) – $13,000 = $277,000.
- Merchandise inventory = (cost of goods available for sale or beginning inventory) – COGS.
What is the difference between inventory and merchandise inventory?
What is merchandise inventory on a balance sheet?